It is good to know that, with major issues looming such as a government shutdown and the need to extend the debt ceiling, some of our representatives in Congress are focused on pieces of legislation like the Mind Your Own Business Act of 2021. Senator Marco Rubio announced that he had introduced this legislation last week, with the purpose of enabling shareholders to hold “woke” corporations accountable. The announcement states:
Specifically, the legislation would require corporate directors to prove their “woke” corporate actions were in their shareholders’ best interest in order to avoid liability for breach of fiduciary duty in shareholder litigation over corporate actions relating to certain social policies. It would also incentivize corporate management to stop abusing their positions to advance left-wing social policies by increasing their personal liability to shareholders for breaches of fiduciary duty resulting from those policies.
The provisions of the legislation include the following:
Requiring large public companies listing on national stock exchanges to provide shareholders with significant holdings with certain privileges with respect to claims for breach of fiduciary duty under covered circumstances, including if a company takes an action on a primarily non-pecuniary basis in response to State law, boycotts a class of persons or industry on a primarily non-pecuniary basis, or uses primarily non-pecuniary public reasoning for an action.
Corporate defendants would be bound by presumptions that pecuniary interest does not include common defenses used to defend exercises of business judgment, including the media image of the company or employee morale.
For claims of breach of fiduciary duty against management brought by shareholders under these covered circumstances, management would have the burden of proof and, if found in breach of their duties, be liable without indemnification by the company for a minimum amount of damages and attorney’s fees.
We will monitor the progress of this legislation, but my guess is that, in the current political environment, this one might be singing “I’m just a bill/Yes, I’m only a bill/And I’m sitting here on Capitol Hill.”
The SEC announced that John Coates, who served as Acting Director of the Division of Corporation Finance and then as Acting SEC General Counsel, will leave the SEC in October to return to teaching at Harvard University. Dan Berkovitz, who now serves as a Commissioner of the CFTC, has been named SEC General Counsel. Michael Conley, currently the SEC’s Solicitor, will serve as Acting General Counsel until Berkovitz joins the agency. As noted in the SEC’s announcement, SEC Chair Gary Gensler and Berkovitz previously worked together when Berkovitz served as the CFTC’s General Counsel from 2009 to 2013.
I look forward to participating in our upcoming conferences on October 13-15. I will be speaking with Renee Jones, the Director of the Division of Corporation Finance, on October 14th about all of the things that are happening in the Division right now, and then I will be joining the “SEC All-Stars” on October 14th and 15th to cover proxy season highlights and executive pay nuggets. With so much going on in the world of public company disclosure and corporate governance right now, I encourage you to sign up for these important conferences if you have not done so already!
This is a big week in Washington, as Congress works through a number of significant pieces of legislation, including funding the government for fiscal 2022 (the government fiscal year ends on Thursday). With all of the partisan fighting going on, we find ourselves hearing yet again about the threat of a potential government shutdown. So we must ask ourselves — what could a government shutdown mean for the SEC this time around?
A few weeks after I joined Corp Fin back in 1995, there was talk of a government shutdown and we sat through a flurry of internal meetings explaining what might happen if the agency did actually have to shut down. Having only worked in the private sector before coming to the SEC, I recall thinking “what did I get myself into?” Thankfully, the partial government shutdown that ensued for 21 days back then did not impact the SEC’s operations – the agency found money from somewhere, and was able to continue normal operations. Government shutdowns that have happened since then generally followed that same pattern, where part of the government shut down but the SEC kept going. That was of course until the end of December 2018, when we saw the SEC’s operations were almost completely curtailed for almost a month until the shutdown ended on January 25, 2019.
Something that the 2018-2019 shutdown taught us is that you cannot count on the SEC’s ability to find “emergency” appropriations to keep the lights on, so be prepared for when the inevitable “real” shutdown happens. With each successive shutdown, we get more guidance from Corp Fin and we all develop more experience dealing with the consequences. During the prolonged shutdown in 2019, we dealt with some very knotty issues, such as dealing with pending registration statements (e.g., considering whether to remove the delaying amendment) and shareholder proposal no-action requests (e.g., considering whether to exclude a proposal without a Staff response). Given the present uncertainty, now may be a good time to take a look at the coverage of the Staff’s shutdown guidance from early 2019, and plan accordingly. If you have a registration statement pending with Corp Fin or are otherwise awaiting action from the Staff on some matter, reach out to your contact now so you can get a sense of the Staff’s timing. Also, begin making contingency plans, just in case a shutdown happens (and drags on more than a few days).
The SEC announced that Erik Gerding has been named Deputy Director, Legal and Regulatory Policy, for the Division of Corporation Finance, effective October 4, 2021. Prior to joining the SEC, he has been a Professor of Law and a Wolf-Nichol Fellow at the University of Colorado Law School. Professor Gerding’s areas of focus have been corporate and securities law and financial regulation. He previously taught at the University of New Mexico School of Law and practiced in the New York and Washington, D.C., offices of Cleary Gottlieb Steen & Hamilton LLP.
Yesterday, the SEC announced that it had delivered its obligatory report to Congress regarding the proceedings of the agency’s 40th Annual Small Business Forum, which took place back in May. The Annual Small Business Forum is led by SEC’s Office of the Advocate for Small Business Capital Formation and typically involves the Commissioners and representatives of other SEC Divisions and Offices. The report to Congress describes the event in detail and publishes policy recommendations from the event, along with public comment on those recommendations. The twenty policy recommendations are grouped in four topic areas: finding your first dollars, doing your diligence, diversifying capital allocators and small cap insights.
Earlier this month, I blogged about falling off of the Rule 15c2-11 cliff when changes to the rule go into effect tomorrow. Rule 15c2-11 specifies the information that brokers must have to initiate or maintain quotations in OTC securities. While much of the focus has been on the impact of the rule changes on the quotation of equity securities of smaller issuers in the OTC markets (i.e., the cessation of quotations for a large number of issuers who are not able or willing to provide the required public information), Rule 15c2-11 applies to the quotation of fixed income securities, except for exempt securities such as U.S. treasury securities and municipal securities, which are specifically exempted from Rule 15c2-11.
On Friday, the Staff of the SEC’s Division of Trading and Markets issued a no-action letter to FINRA stating that the Staff would not recommend enforcement action until January 3, 2022 for quotations published by broker-dealers for fixed income securities in order to “allow for an orderly and good faith transition into compliance with the Amended Rule.” The no-action letter indicates that it was issued in response to “requests from industry representatives that have indicated through telephonic meetings with Commission staff that they may be unable to complete, by the compliance date of September 28, 2021, the operational and systems changes necessary to comply with the amendments to Rule 15c2-11…for fixed income securities.”
Commissioner Hester Peirce issued a statement on Friday supporting the Trading and Markets Rule 15c2-11 no-action letter, but disagreeing with the very short extension of the compliance date for fixed income securities. She stated:
The Commission’s amendments to Exchange Act Rule 15c2-11 that were finalized last fall will take effect next week. In recent months, market participants have raised concerns about the potentially significant negative effects of these amendments on trading in the fixed-income markets. I agree with the staff of the Division of Trading and Markets that relief is necessary to forestall these effects. However, the time-limited relief—three months—being granted in the no-action letter released today is wholly inadequate to that need. Instead, we should issue longer Commission-level no-action relief and reopen the rulemaking as part of a broader fixed-income modernization initiative.
Commissioner Peirce’s statement indicates that while the text of Rule 15c2-11 has always contemplated application of the rule beyond equity securities, “there appears to have been limited, if any, application of the rule to fixed income markets prior to the Commission’s 2020 adopting release. Nothing in the adopting release suggests that the Commission considered the application of these rules to the fixed-income markets.”
Commissioner Peirce also noted in her statement that, in the context of the OTC equities market, the changes to Rule 15c2-11 could “have unintended harmful consequences on certain shareholders” which could have been mitigated by the establishment of an expert market; however, as I indicated in this blog, the Staff stated over the summer that the expert market was not on the Chair’s near term agenda. We will see the consequences of that decision beginning tomorrow.
Today, the SEC’s Small Business Capital Formation Advisory Committee will meet, and the Committee plans to discuss changing dynamics for pre-IPO companies raising capital and the pathways those companies take to becoming public. Part of the discussion will focus on “crossover investors” (i.e., mutual funds and other traditional public company investors that now invest in late-stage, pre-IPO funding rounds) and how they are changing the dynamics of pre-IPO capital raising and impacting the timing to go public. The Committee will also discuss pathways going public, discussing “how companies and investors are weighing traditional IPOs, direct listings, and the re-emergence of mergers with special purpose acquisition companies.”
Earlier this week, Activision Blizzard confirmed media reports that it was the subject of an SEC investigation concerning “the company’s disclosures regarding employment matters and related issues.” Regardless of its outcome, the SEC’s decision to pursue such an investigation has proven to be controversial. After all, when was the last time that allegations relating to employment practices caught the eye of the Division of Enforcement?
In defending the investigation, some have observed that the workplace misconduct allegations against the company may call into question the accuracy of the human capital disclosures that appeared in its Form 10-K. But UCLA’s Stephen Bainbridge suggests that the SEC’s investigation represents a revival of the agency’s long-ago abandoned efforts to persuade courts to compel disclosure of uncharged wrongdoing. Here’s an excerpt from his recent blog on the investigation:
Obviously, the SEC will claim that it is about Activision’s allegedly deficient disclosures relating to its Human Resources practices. But even if we accept that risible claim at face value, the SEC is still overstepping its bounds. It’s critical that Activision management has not been convicted of any civil or criminal violations. If they had been, it would be arguable that failing to disclose those convictions would be a material omission (obviously, I realize that one is not convicted of civil violations, but I’m using it as a shorthand).
Where plaintiff complains of noncriminal conduct allegedly constituting mismanagement, courts have been unwilling to require disclosure. In Amalgamated Clothing and Textile Workers Union, AFL―CIO v. J. P. Stevens & Co., 475 F. Supp. 328 (S.D.N.Y.1979), for example, plaintiffs argued that the board of directors had either knowingly violated the labor laws or, at least, failed to prevent management from doing so. According to plaintiffs, this alleged misconduct had harmed the corporation’s reputation and exposed it to liability. The failure to disclose these purported facts in connection with the election of the directors allegedly constituted an omission of material facts. In rejecting plaintiff’s argument, the court held that it would be “silly” to “require management to accuse itself of antisocial or illegal policies.”
Yet, that is precisely what the SEC investigation of Activision assumes management is required to do.
I’m inclined to sympathize with this argument, and I agree that efforts to expand the SEC’s authority beyond financial regulation involve the kind of “mission creep” that threatens its credibility. But I think there’s an important difference between the SEC’s 1970s “qualitative materiality” crusade and situations like this one. Instead of trying to pluck disclosure duties from the ether, this time the SEC has a line-item in its quiver.
Risible or not, that line-item creates a duty to disclose material human capital information, which puts the substance of the disclosure that Activision provided squarely within the SEC’s jurisdiction. The SEC isn’t investigating an omission in search of some amorphous duty to disclose, but whether there were potential misstatements or omissions in response to line-item disclosures that the company was obligated to make.
There’s some irony in the fact that this “principles based” disclosure requirement is being cited as a jumping-off point for a renewed foray by the SEC into the qualitative materiality morass. After all, it was conservatives who championed this “DIY” approach to human capital disclosure, while liberals called for detailed line-item requirements addressing specific metrics. The SEC’s reliance on the new disclosure requirement to investigate conduct that’s pretty far from the core focus of the securities laws suggests that, in the end, the flexibility provided by principles based disclosure requirements may give companies just enough rope to hang themselves.
